Until recently, the derivatives industry was most often ignored, overlooked and dismissed as too complex or arcane to warrant attention in the mainstream. For many who worked deep in the industry, this was just fine. They didn’t seek the limelight or public acclaim. But scandals such as the $1.6 billion disappearance of funds in the MF Global case and a stunning if oddball fraud and suicide attempt at Peregrine Financial Group (PFG) put the industry and its regulators into the limelight. Now that limelight is taking an ugly turn.
Country club elections so common in many elite financial services industry organizations turns ugly
Voting began December 10 for election to the Board of Directors to the National Futures Association and concludes January 19, 2016. Elections that are typically handled in a private fashion similar to a country club have suddenly been engulfed in harsh public charges being made back and forth between some of the most respected names in this industry. To those whose stated goal was to preserve and protect the regulated derivatives industry the developments were stunning, a rarity never before seen, but also ugly in a way similar to players on an already tough hockey team fighting amongst themselves. The team engaging in such ugly infighting seldom wins.
At the center of controversy’s spotlight is a familiar figure, James Koutoulas, an elected board member of the National Futures Association representing derivatives-based hedge funds known as CTA’s and CPO’s. Koutoulas was hailed in 2012 for his efforts on behalf of a portion of MF Global account holders who initially lost funds from their segregated accounts and was swept into office resulting from his popularity generated from the media spotlight. But now, four years and two elections later, a survey of National Association of Introducing Brokers board members shows Koutoulas having diminishing support among the group as he engages in what appears like a cat fight with some of the derivatives industry’s most storied names.
While at first hopes were high, critics charge that Koutoulas introduction to one of the industry’s most elite organizations took an early turn for the worse and the trend is persistent. A “toxic” environment has been created, damaging the interests of those he purports to represent by engaging in the equivalent of spitting vitriol at anyone who opposes him as he continues on a self-promotional tour. Koutoulas, however, says he is fighting a battle with NFA staff to reform what amounts to a clubby environment where leadership decisions are made behind closed doors – yet doing so while maintaining a good if influential relationship with fellow board members, typically the top derivatives industry players among hedge funds, large banks and brokerage firms.
The election he-said, she-said battle reached a crescendo recently when noted industry publisher John Lothian, in an endorsement of his opponents, labeled Koutoulas a “bombastic loose cannon.” Koutoulas quickly fired back, saying he might sue Lothian for libel after the election, reported first by Lothian but also by Matt Smith of CTA Intelligence. Koutoulas claimed Lothian broke the law by sending email directly to 2,500 NFA members in which Koutoulas was characterized as “incapable of being trustworthy.” Koutoulas said Lothian made the statements without supporting documentation. ”I’m a lawyer and a pretty good one,” Koutoulas said in a ValueWalk interview regarding Lothian’s initial charges, pointing to whistleblower cases. “I fight back.” Sources close to the NFA, however, said that using NFA member emails in this fashion was acceptable.
John Roe, a fellow NFA board who co-founded the Commodity Customer Coalition with Koutoulas and is running for election alongside him, lowered the temperature of boiling water. He responded to Lothian’s endorsement by speaking to issues such as increasing compliance costs harming smaller emerging hedge fund managers and pointing to “tangible accomplishments we have achieved on behalf of customers and the industry,” a reference to the pair’s advocacy in both MF Global and PFG incidents.
After Koutoulas board position is challenged, issues over public board nominations appear
In his initial election by CTA and CPO members in 2012, Koutoulas received wide spread support, including from Lothian. In a subsequent 2014 election the influential NFA nomination committee took the unusual step of endorsing Koutoulas alongside an alternative candidate and Lothian did not endorse. Sitting board members were traditionally endorsed for re-election unchallenged.
Koutoulas then publicly accused the NFA of procedural violations when it appointed public directors unrelated to his nomination. He would ultimately call actions taken by a senior NFA staff member in the matter “heinous,” engaging in what some industry observers described as an attack on personal reputations. Critics charged that Koutoulas was upset that the NFA did not endorse him unchallenged. Koutoulas, however, claims he is fighting to reform the NFA, which he says “is like trying to turn around the Titanic.
For nearly 30 years the nomination of prestigious NFA public directors, the subject of the Koutoulas complaint, was taken by an informal voice vote and typically approved with unanimous consent. In this case NFA Board Member Jack Sandner, the retired chairman of the CMEGroup, appointed directors in 2014 but Koutoulas charged the NFA didn’t follow its own procedures and subsequent record keeping contained inaccuracies, highlighting increasing tension between Koutoulas and influential industry participants. Current public board members include Michael Moskow, vice chair and distinguished fellow at the Chicago Council on Global Affairs; Jill Sommers, a former CFTC Commissioner; and Andrea Corcoran, a distinguished former CFTC official and now a principal at Align International.
NFA Chairman Chris Hehmeyer hired the law firm of Skadden, Arps where Mark Young, a former CFTC general counsel, worked on the case to investigate the issue. Young issued a clean bill of health, but Koutoulas disputes the results of the report, saying among other issues it was not technically a legal opinion.
Koutoulas pressed the issue of public director nomination impropriety with the Commodity Futures Trading Commission, asking the agency to investigate. “The CFTC is not exactly moving at blazing speed, but it is moving,” Koutoulas said. “The CFTC is underfunded and the issue does not concern security of customer segregated funds so it is not moving quickly.”
Others disagree. “I just know the allegations are wholly without merit… James is trying to get elected,” Hehmeyer told Tom Polansek of Reuters in January.
NFA election mirrors many of the most significant issues in financial services
In part the election is a mirror of some of the financial services industry’s top issues. In a position paper, current NFA Board Members Douglas Bry and Ernest Jafferian, those opposing Koutoulas and Roe respectively, addressed high frequency trading (HFT) and compliance challenges as the major issues, touting their MF Global bonafides as well. The pair had actively advocated for NFA to take a close look at HFT and “in particular abuses like spoofing (placing orders to impact the direction of the market and pulling them before anybody can trade against them), which are harmful to the markets and in particular our members.”
While the Koutoulas and Roe position paper does not specifically address high frequency trading, Koutoulas said in an interview they have significant hands on experience in the area. Roe is president of BTR trading, which in part connects algorithmic traders with a registered Futures Commission Merchant and enables them to trade. Koutoulas runs the hedge fund Typhon Capital Management with over $80 million under management and six strategies, three of them in agricultural markets that are award winning. Koutoulas also points to blocking efforts by large hedge fund Citadel to seek exemptions before the NFA as an example of his activist approach on the board.
Bry, for his part, ran a $100 million trend following CTA, Northfield Trading, before becoming a senior strategist at Welton Investment Partners in January of 2015. Jaffarian ran the managed futures department for Blair Hull’s Hull Equity Management LLC before founding the fund of funds firm Efficient Capital Management, which has nearly $1 billion under management and is known to have a portfolio sleeve dedicated to providing qualified emerging managers seed funding.
The four board members are running for election to two seats, as the board was trimmed down recently and provides less representation to smaller hedge funds. Koutoulas said such change was one of several efforts by NFA staff to maneuver to remove him from the board.
All candidates point out their devotion to fighting for MF Global customers as important to their candidacy. Bry and Jaffarian point to their support of banning former MF Global CEO Jon Corzine for life. The pair issued an influential memo advocating elite industry participants actively engage in the issue, pointing to how their voice is heard in powerful quarters. Koutoulas, for his part, noted that he and Roe had devoted 3,000 hours pro-bono to assist MF Global and PFG customers, thumping his chest over an NFA resolution he spearheaded attempting to ban Corzine from derivatives trading for life as pushing the CFTC to initiate a legal case against him one month later. Sources had pointed to other causation motivations being involved in the decision.
While all candidates have contributed mightily to the MF Global cause, the ultimate causation for success is likely to be more nuanced than to be centered on any one individual or group. Regulatory and investigative staff at a variety of organizations are likely to emerge as deserving of significant credit. Grass roots advocacy that worked with the system was important – engaging regulators and the U.S. Department of Justice. In the end, MF Global might show that “eiltes” and “the establishment,” to which scorn is so easily heaped on in this presidential election season, is deserving of sharing a large degree of the MF Global hero podium when all is said and done. That is assuming the truth is told one day. For his part, Koutoulas lauds the CFTC for their “bravery” in taking on the politically connected Corzine and defending the industry’s most sacred customer funds protection regulations. He expects a trial to commence in February, but no official date has been set.